Reduce the Cost of Your Long-Term Debt
Save money on long-term loans—a free audiobook excerpt from Money Girl’s 10 Steps for a Debt Free Life.
Laura Adams, MBA
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Reduce the Cost of Your Long-Term Debt
How to Get Rid of Long-Term Debt
In the context of personal finance, long-term debts are obligations you’ve made that are due to be repaid more than five years or so into the future. Having long-term debt is generally thought of as less dangerous than having short-term debt. So, once you’ve confronted your top-priority short-term debts, you’re in a position to deal with the less dangerous ones—the long-term debt. Long-term debts, such as mortgages and student loans, are as common today as blue jeans. That’s because even the average price of homes and the cost of a basic college education are out of reach for most. These high-ticket items become affordable only when the price is stretched out over many years.
If the principal amount and interest rate of long-term loans are reasonable, then the monthly payment can remain manageable for most people with steady incomes. But as we know, many folks got swept up in the mortgage craze of the early and mid-2000s and borrowed too much money. They actually didn’t earn enough to justify such high loans, some with wildly fluctuating adjustable interest rates. In combination with the recession’s job losses, declining home sales, and the resulting rock-bottom home prices, many are now “upside down” or “underwater” on their mortgages.
Reevaluate Your Mortgage
Those are terms taken from the auto industry that mean you actually owe more than the asset is worth. Whether you’re in this predicament or not, it’s a good idea to take a look at all your mortgage loan options. If you have a mortgage and are like most people, it’s likely that you won’t pay it off until you reach old-age or perhaps stumble on a winning lottery ticket! So, it’s smart to reduce the amount of interest you’ll pay over the life of your long-term loans.
How to Pay Off Your Mortgage Faster
Your job in reducing long-term debt is to consider all the alternatives for paying it down. Sometimes we get fooled into thinking that small changes in interest rates aren’t worth the hassle of doing a refinance or a loan consolidation.
Here’s an example to help you see how small changes in interest rates can make a huge difference over the life of a long-term loan. Let’s say you bought a $200,000 house with a 5% down payment. That means you put $10,000 down and mortgaged the remaining $190,000. If your loan is to be repaid over 30 years at a 6.75% fixed rate of interest, you’ll pay a whopping $253,641 just in interest! That doesn’t even include the $190,000 in principal you have to repay. If interest rates for 30-year fixed rate mortgages go down to 6% from your current rate of 6.75%, you may mistakenly think that the 0.75% difference isn’t worth the hassle. Let’s see…
If you refinanced the loan for 30 years at the new interest rate of 6%, by comparison you’d pay $220,092 in interest. That’s a savings of $33,549 in interest over the life of a 30-year loan. I’d say that’s well worth the hassle, no? The “re-fi” would reduce your monthly payment from $1232 to $1139. Now you’d have just about $100 extra each month to pay down short-term debt. Be aware that there are closing costs and fees for refinancing a loan. You must weigh those costs against the potential long-term interest savings you’d enjoy.
There’s a great refinance calculator at dinkytown.com that can help you know how long it would take to breakeven on the cost of doing a mortgage refinance. I’ll put links to the refinance calculator and to a couple new government programs that you may want to consider at moneygirl.quickanddirtytips.com.
Should You Get a Loan Modification?
However, before you decide to embark on a mortgage refinance, I highly recommend that you approach your current lender about doing a loan modification. A modification is basically a refinance that’s both easy and free. The lender pays all fees to process the paperwork. If your income has been substantially reduced or if you don’t have funds available to do a typical refinance, you may be a perfect candidate for a modification. The lender will ask you to submit your income and expenses on an application. They review your information to determine if the loan payment is too high for your current income. If so, the lender adjusts the interest rate down, extends the term of your loan, or does both.
If you don’t qualify for a modification, and have anything other than a conventional 15 or 30-year fixed rate mortgage, it’s in your best interest to contact a couple different lenders about your options. Everyone’s situation is different and the loan market is always changing. A good lender or mortgage broker should be able to make some suggestions for your circumstances. You can do some preliminary research at one of my favorite websites, bankrate.com.
Administrative
In the Money Girl section of QuickandDirtyTips.com you can find my Twitter link, e-mail address, podcast widget, show transcripts, and more. If you or someone you know needs help getting out of debt, remember that Money Girl’s 10 Steps for a Debt Free Life. is now on sale at Audible.com and in the iTunes store.
I’m glad you’re listening. Chi-Ching, that’s all for now, courtesy of Money Girl, your guide to a richer life.
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Debt image courtesy of Shutterstock
About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.